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    negative expected rate of return on a security/asset

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    Need assistance in explaining these two parts

    Part 1) Suppose rf is 5% and rM is 10%. According to the SML and the CAPM, an asset with a beta of −2.0 has a required return of negative 5% [= 5 − 2(10 − 5)]. Is this be possible, why or why not?

    Part 2) Does this mean that the asset has negative risk? Why would anyone ever invest in an asset that has an expected and required return that is negative? Explain.

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    Solution Preview

    It is possible to have a negative expected rate of return on a security/asset. The reason it turns out to be negative is that the beta of the security with the market is negative. CAPM formula is

    E(Ri) = Rf + Beta (Rm - Rf)


    Beta = Cov(Ri, Rm)/ Var(Rm)

    Since beta is ...

    Solution Summary

    In this solution, we show how to rationalize a negative expected rate of return on a security/asset.